(Reprinted from HKCER Letters, Vol.45, July 1997)
China in the New World Trading
Environment After the Uruguay Round
One of the characteristics of the successful Chinese economic reform is the rapid expansion of foreign trade. Within sixteen years of reform (1980-1995), Chinese foreign trade has increased by 636 percent and exports have increased by an astonishing 721 percent. In 1978 China's share in total world trade was a mere 0.85 percent, while in 1994, China's share had increased to 2.9 percent. These results were achieved despite the fact that China is still outside the most important international organization governing trade--the World Trade Organization (WTO, formerly GATT).
The Uruguay Round of negotiations of GATT marked a new era in the international trade environment. It further reduced tariff and non-tariff trade barriers and expanded into other areas such as trade in services, trade-related intellectual property protection, and trade-related investment measures. However, after ten years of effort, China is still outside the international trade club GATT/WTO. Without the sanctuary of WTO, as Chinese exports grow, trade frictions have increased and foreign protectionism will gradually show its negative impacts on Chinese exports. In addition, Chinese economy has been reforming for close to twenty years now, and the gains from reform may be exhausted within ten to fifteen years time. China will increasingly need to depend on technological change to improve its competitiveness. Hence, what happened in the past may not be a good predictor of what will happen in the future, and it is important to re-examine Chinese strategies in order to excel in the new trade environment after the Uruguay Round.
Explaining Past Performance of Chinese Foreign Trade
There are three main reasons explaining China's past miraculous trade performance. The first and most important reason is the reform of the foreign trade sector, with the introduction of the agency system, the gradual devaluation of the RMB to its market level, and the open door policy which helped to attract foreign investments. In 1980 the official exchange rate was set at a heavily overvalued level of 1.498 RMB/US$; in 1994, the year that China unified its official and black market rates, the value of the RMB had been gradually devalued to 8.62 RMB/US$. In 1980 foreign-invested enterprises generated only 0.05 percent of China's exports, and in 1995, 31.5 percent of Chinese exports were generated by foreign invested enterprises.
Secondly, even though it was not a member of GATT, China managed to obtain a reasonable level of market access through bilateral negotiations with trading partners. All of China's major trading partners except the United States granted China unconditional MFN status, which allowed China to benefit from low tariff rates, that are available to member countries of GATT. Hence, not being a member of GATT has not significantly affected Chinese foreign trade. As a matter of fact, China outperformed the average normal country by a significant amount. After taking into consideration market size, level of economic development, and other factors such as language and distance between trading partners. I found out that in 1990 and 1992 China traded 72 percent and 46 percent more than the average country respectively.
The other factor driving China's export growth is China's abundant supply of cheap labor. The simple logic of comparative advantage will allow China to become the most important supplier of labor-intensive products in the world market for many years to come. According to my analysis, using 1991 to 1994 trade data at the three-digit SITC level, except petroleum and related products, nine out of ten of China's top ten export products are labor-intensive manufacturing products, such as footwear, baby carriages, toys, games and sporting goods, and clothing and apparel products. Textile and apparel were China's most important foreign exchange earner, and five of China's top ten export products belong to the textile and apparel industry.
Patterns of Chinese Foreign Trade
Unlike Japan, on average China did not have a large merchandise trade surplus. Unfortunately, distribution of Chinese foreign trade has not been very even. China heavily depends on the U.S. market for its exports. In contrast, the U.S. plays a much less important role in supplying Chinese imports. This asymmetry has led to a huge bilateral trade surplus. For example, in 1994, 17.7 percent of Chinese exports were destined for the United States but only 12 percent of Chinese imports came from the United States. Japan shouldered, or absorbed, roughly the same amount of Chinese exports (17.8 percent) but Japan supplied almost 23 percent of total Chinese imports, much more than the United States. More careful analysis-taking into account important factors such as market size, level of economic development, and distance between trading partners gives us the same conclusion. It can be shown that, in 1990, Sino-U.S. trade exceeded China's norm by 131 percent, and in 1992, by 90 percent. On the other hand, Sino-Japanese trade was 16 percent below China's norm in 1990 and only 4 percent above China's norm in 1992.
As expected, Chinese exports to the U.S. exceeded China's norm, while China's exports to Japan were below China's norm in 1990 and 1992. Uneven distribution of Chinese foreign trade may be due to differences in the comparative advantages of different countries and does not indicate any wrong doing on the part of China. However, this distribution of Chinese foreign trade has had the unfavorable and negative effect of causing bilateral trade frictions, especially with China's largest trading partner, the United States.
Similar conclusions can be obtained at the disaggregate level. From 1991-94, the U.S. was the largest market for six of China's top ten export products and the second largest market for the other four of China's top ten exports. Japan was the largest market for four of China's top ten export products and the second largest market for six of China's top ten export products. On the import side, however, except for aircraft and associated equipment where the U.S. supplied 82 percent of China's imports, the U.S. has been a minor supplier for all of the other Chinese top ten import products. In contrast, Japan was the largest supplier for six of China's top ten import products.
Europe, Japan, and the United States are China's major markets. Good trade relations with these countries are essential for further expanding Chinese exports. According to my analysis, using three-digit SITC trade data from 1991 to 1994, China is within the group of top ten suppliers in all three markets for China's top ten products, indicating that China captures an important market share for its major exports. In addition, China is either the number one or number two supplier in all the three markets for China's top five textile and apparel products. However, other Asian exporters such as Malaysia, Pakistan and Thailand are also among the top ten suppliers for all of China's top ten export products, indicating potential competition from other Asian developing countries.
The "New World Order" and China's Strategy
China's excellent trade performance in the past has the United States worried that China may become a second Japan. This worry signals the challenging trade environment ahead. Already, China was designated as the priority country on the U.S. s 301 list in May 1996. For the same reason, major member countries of the WTO have been insisting China join WTO as a developed country, which means that China has to liberalize its economy at a much faster rate than most developing countries, which usually are allowed a longer grace period for cutting down trade barriers--this, even though China's per capita income is still among the lowest in the world.
The United States used to dominate the world both in terms of economics and other global affairs. This is still the case today but changes are gradually taking place. New important players have emerged, and this will gradually lead to a new world order where there is more than one significant player. The Europeans have formed their single market and they are learning to speak with one voice. Japan's economic power has increased significantly and Japan is also learning to play more important roles in international affairs. The United States is the key player in determining the conditions for China's entry into WTO and in pressing for more trade concessions from China in all areas of trade liberalization, market access in general, and trade-related intellectual property protection. Under the scenario of more than one economic superpower, China can potentially play the European card to obtain more favorable trade concessions from the United States. This is mainly due to the fact that Europe produces similar products as the United States and is a competitor in the world market. Market lost by the United States can potentially be captured by European producers and vice versa. Hence, playing the European card will hit right at the heart of the objective of American trade policy: promoting U.S. export interest in the international marketplace.
Joining WTO will allow China to benefit from low tariff rates and the ten-year phasing out of one of the most important quantitative export restrictions--the Multi-fibre Arrangement (MFA). It will also allow China to benefit from the strengthened WTO dispute settlement (DS) system and will give China more bargaining power in case of trade disputes. A relatively favorable trading environment allowed China to reap the benefits of reform policy fairly quickly and to establish momentum for continued economic reform. Maintenance of a relatively friendly external trading environment is important for China's economic growth in the future. This is not only because, on an absolute scale, China can benefit from international trade due to the basic principles of comparative advantage and gains from trade, but also because the world is increasingly competitive, and a small disadvantage may lead to the loss of competitiveness in an industry. Without being a member of WTO, China risks not being able to compete with other countries with similar comparative advantages. However, even if China cannot join WTO in the short run, I would suggest not being too pessimistic for the following reasons.
First of all, after many rounds of tariff negotiations, tariff levels have already come down significantly. China has unconditional MFN status with its major trading partners except the United States. Even though the United States can potentially refuse China MFN status, it is unlikely to do so because such a refusal would lead to a major trade war which can be very harmful to both China and the United States. Hence the possibility of a refusal happening under normal circumstances is very low. China has strong bargaining power because of its large trade volume and huge potential market size that no other developing countries can even compare with. With MFN status, China will be able to enjoy the benefit of low tariff barriers provided by WTO.
The second reason not to be pessimistic concerns one of the major achievements of the Uruguay Round of negotiations: the ten-year phasing out of the most important quantitative restrictions on developing country exports--the Multifibre Arrangement (MFA). Textile and apparel are China's most important export engines, and not being able to participate in this phasing out can potentially be very damaging to China's exports. However, it should be noted that the agreement on textile and clothing (ATC) trade allows developed countries tremendous flexibility, and most of the benefits are back-loaded so they will not materialize until the end of the phasing out period, which is eight years away. By that time China should have joined the WTO already, and the ATC agreement should become an non-issue then. In the meantime, if developed countries are serious about the full implementation of the MFA phasing out, there are still reasons to believe that China should be able to obtain reasonable market access to foreign markets, as it did before. This is because even without China's participation, free textile and apparel trade will significantly enlarge developing countries market share, so developed country suppliers will have to turn to the capital- and technology- (or technology design-) intensive segments of the industry for survival. Hence, China will not be competing directly with developed country producers. In this case, restricting Chinese textile and apparel exports will only increase the price of the low-end textile and clothing products, which is harmful to developed country consumers, especially low-income consumers, without helping developed country producers. Hence, it is not in the interest of developed countries to restrict Chinese textiles in favor of other textile producers. The recent Sino-U.S. textile and apparel quota agreement in February 1997 is consistent with my predictions.
The Uruguay Round has further strengthened the WTO Dispute Settlement (DS) system; however, the effectiveness of WTO DS is still limited. It is still a power-oriented rather than rule-oriented system. This conclusion follows from the fact that the maximum penalty for being inconsistent with GATT/WTO provisions is a retaliation which is next to meaningless for less powerful developing countries. Therefore, China may not lose that much by not being able to use the WTO DS. However, WTO DS should not be discredited completely. It should be recognized that a retaliation order from the WTO will carry more political weight than a retaliation threat initiated single-handedly by China alone.
In conclusion, continued reform in all areas in China is the fundamental driving force of China's economic success for the past and will continue to be so in the near future. As the Chinese economy becomes more market-oriented, Chinese domestic producers will be more competent and this will in turn reduce the short-run adjustment costs of opening China for foreign competition. Reduced adjustment costs will reduce the political costs associated with trade liberalization and make it more likely for China to further reduce trade restrictions on a unilateral basis. A less restrictive Chinese trade regime will allow China to get reciprocal treatment from foreign countries. Very importantly, a rapidly growing economy will make China one of the largest potential markets in the future; it will provide the ultimate bargaining chip for China. Hence, domestic economic liberalization in China is important for economic development and for obtaining reasonable market access abroad. Continued domestic reform is the key to the future success of the Chinese economy.
Dr. Haiying Zhao is lecturer in the School of Economics and Finance, the University of Hong Kong.